Falling incomes, falling prices

A specter is haunting the California real estate market — the specter of income inequality.

Say what you will about the apparently robust real estate market recovery — even a sick market can be flush with rising prices. As is clear to those who examine the present price spikes with a cool head, we are in the midst of a mini-bubble generated by the fever of home price speculation.

Many market factors have led to this moment’s bubble, including:

the perception of depressed prices;

a past glut of REO and distressed property supply;

tight credit for end-users;

an abundance of un-lent institutional cash reserves; and

extremely favorable investor wealth conditions produced by the Fed.

Also, there are a number of different players on the scene contributing to this year’s asset price inflation. Included in the fray are impatient end users who are getting caught up in bidding wars with investors and speculators. But whatever the arguable causes of the current bubble, it is clear that rising home prices have not resulted from a stronger economy — at least not a jobs recovery proportional to the price spikes we have witnessed since January 2013.

To judge the true direction of home sales volume and real estate prices, you need look no further than jobs. Yes, unemployment is falling (albeit an amount roughly equal to the decline in labor force participation) and the Fed projects it may even fall below the target 6.5% by 2014. But for most ready and willing potential buyers, having a job doesn’t mean a whole lot if it doesn’t provide enough income to save for a down payment and cover homeownership operating expenses.

For them to be ready, agents must consider incomes.

A tale of two incomes

An overview of income fluctuations since the financial crisis reveals that incomes for the majority of Americans have suffered disproportionally, which has adversely affected their home purchases compared to the top 1% of income earners in the U.S.

During the Great Recession (2007 – 2009), real incomes for all Americans declined by 17.4%, according to a study by University of California, Berkeley economists. Incomes in the top 1% actually suffered a much greater shock comparatively, with a 36.3% decline. The 1% realized the greatest income losses during this time since they are rentiers. By definition, rentiers earn their income by collecting rents (dividends or interest) on their investments rather than through labor. Rentiers are always more susceptible to shocks from financial crises since their incomes are directly tied to the performance of financial markets.

During the 2009-2011 recovery period, average incomes increased modestly by 1.7%. This gain, however, was not shared equally among all income brackets. Rather, the top 1% saw a gain of 11.2% whereas incomes for the remaining 99% — ahem, your homebuyers — actually continued to shrink by 0.4%.

Thus, the top 1% grabbed 121% of the income gains created in the initial two years of the recovery. So who’s buying up all this property of late?

Considering the intimate linkage between incomes and home prices, it seems absolutely confounding that prices on low- and mid-tier homes have been able to move at all. It’s even more shocking that prices on these homes have moved the most!

Prices always adjust to what buyers can pay, as we learned again in our past recession. Determine the amount of purchase-assist funds available to the middle-class and you will, ipso facto, divine the future of the real estate market.

Of course, there are two sides to the buyer purchasing power coin: one side is incomes, the obverse is interest rates. If interest rates on 30-year fixed-rate mortgages (FRMs) are driven low enough by lack of demand, a buyer’s income insufficiencies are absorbed by the increased purchasing power afforded by lower rates. This is the primary reason for most of real estate price increases since 1979, with the phenomenal asset price inflation we saw during the Millennium Boom fed by buyer purchasing power, which then spiraled out of control due to the financial accelerator effect.

Thanks to the Fed’s aggressive monetary policy since the dawn of the Great Recession, the buyer purchasing power index remained positive through May 2013, allowing those with stagnant incomes to purchase the same amount of home, if not more, than they could have several years prior. This fact alone has kept prices mostly flat during the recovery. But prices have spiked, thanks at the moment almost exclusively due to speculation.

A positive buyer purchasing power index bodes well for real estate sales volume and prices. But what happens when interest rates increase and buyer purchasing power goes negative? Well, it’s quite simple — prices will go with it.

The Fed has benchmarked their withdrawal from monetary stimulus to the unemployment rate. This does not mean equal relief for home sales prices since it says nothing of wages. Wages will remain stagnant at best and fall at worst when the government, as the employer of last resort, fails to provide for a rapid recovery of jobs lost.

Until then, the long-term unemployed will continue to accept ever-lower wages if and when employment becomes available. Since there is low demand for labor, workers have very little leverage in demanding a higher wage. Thus, we’re in the midst of a vicious cycle of wage stagnation that will adversely affect our real estate markets.

Once unemployment reaches the Fed’s target, they will start their withdrawal from the mortgage-backed bond (MBB) market. This action will send mortgage rates on a steady upward trek. The move in rates will slowly but surely eat away at buyer purchasing power since it will not be offset by an equivalent increase in incomes.

So, we have another persuasive indicator of the future price movement of California real estate.

We know speculators are driving up prices with their cash offers and bidding wars on each new listing that hits the market. We know interest rates will increase, if for any other reason than that they have nowhere to go but up. Additionally, Ben Bernanke said as much in the most recent Fed announcement, which is why the bond market panic took place mid-June.

Introduce stagnant incomes for 99% of the population to this equation and a substantial price decline back to the mean price level becomes glaringly clear. Of course, allowing loan assumptions for existing 3.5% mortgages in the coming era of rising rates and falling buyer purchasing power would go a long way in mitigating the otherwise inevitable sales volume and price declines.

But if you want loan take-over rights again, you’ll have to fight for it.

3 Comments

Sabine Alberti
on July 18, 2013 at 9:52 am

Income inequality will always be with us, and always has been there. In a liberal pipe dream everybody would have the same income, the same talents, looks, health and IQ.
Sadly, this is a delusion, my friends! Income inequality has nothing to do with house prices!

Income inequality does not drive anything. The pathetic nature of a recovery recovery which is creating mainly part-time jobs will prevent people from purchasing a home and, for some, mean that they need to share rentals.

The lesson to learn is that it takes much longet top recover from a borrowerd money houing bubble than it does, for example, to recover from the dot-com bubble.

Borrowed money bubbles affect the banking system which decreases lending and business growth.

Income inequality absolutely won’t ( and can’t) lead to lower home prices because it is the 50% with money that comprise the 50% of the population who own their own home and the 50?% without money are those who comprise the 50?% of the population who rent.

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